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A college education can be one of the greatest, and most expensive, investments you ever make.

This investment in oneself can boost early career development, but it comes at an ever-increasing cost. According to one study, the average college costs (tuition plus room and board) in 2023 were $30,884 per year. For a four-year degree, we’re talking more than $120,000 in today’s dollars…and that’s not even factoring in inflation for the future!

No wonder there are 43 million Americans with college debt! But your kids (or grandkids) don’t have to be one of them.

Here’s how you can save for college and conquer this mountain.

The Math

Whether you plan to pay college costs for your kids, grandkids, or even yourself, here are some numbers to get you started.

If you’re fortunate enough to start saving from the day your child or grandchild is born, then you’re going to have the greatest use of the power of compounding returns.

Let’s assume that $120,000 is the number we’re going for, but also remember that college tuition costs have risen faster than the average inflation rate over the last 50 years. While it’s difficult to predict what this inflation rate will be over the next 18 years, the inflation rate has been falling steadily over the past 20 years. So according to this study, let’s assume the inflation rate going forward will be an average of the last 10 years at about 2.65%.

In 18 years, when that child is ready to attend college, let’s estimate a total four-year cost at $192,000.

So where do we start?

Here are three things to consider.

Save the Whole Thing

If you’re planning to pay the entire college tuition outright, it’s not cheap, but it can be done. Assuming an annual average rate of 9% (that would imply a well diversified equity strategy), saving $388/month at this return rate would grow to the $192,000 we needed over 18 years.

Split the Bill 50/50

It’s easy to take something for granted if it’s handed to you free of charge. This goes for a college education as for anything else.

If you want your kid to have some skin in the game, so to speak, perhaps you choose to split the bill in whatever way seems most fair to you. An easy split would be 50/50, which encourages application to scholarships and strong academic performance for the student to reduce his or her 50% share. Saving for only $96,000 over 18 years would mean $194/month at 9% average rate of return.

Save a Lump Sum

If you’ve saved a nest egg in the bank already, you might actually be capable of putting a lump sum amount into investments to jumpstart your savings. At a 9% interest rate, $40,000 today could grow to something approaching $192,000 in 18 years. Since most people don’t have $40,000 lying around, what if you could do $15,000 today? That only leaves you $245/month that needs investing at an average 9% rate to cover the whole college cost.

Remember, even though the government is not going to pay for free college, it does offer to all but the ultra-high earners (as of 2024) a $2,000 child tax credit. There’s the first $167/month handed back to you from the IRS!

But what about taxation on all those earnings over 18 years? Don’t we need to account for that? Not if we know the tools available to us.

529 Savings Plan

Every state offers their own version of a 529 Savings Plan.

These are tax-deferred investment accounts that can be withdrawn tax-free (federal and state) when used for qualifying educational purposes. This used to include only college costs, but as of 2017 and 2019, now can also cover K-12 education (up to $10,000) as well as apprenticeship programs.

Unlike retirement accounts, there is no annual limit to how much you can put into a 529 plan. So you can fund it as quickly or as slowly as you like! Some states do have a maximum allowable total contribution, but these numbers are into the hundreds of thousands of dollars.

One drawback is that you are limited to a small selection of investment products within the 529. If you prefer to keep things simple, set it and forget it, most offer target date funds which account for your child’s age and adjust investments over time to become less aggressive.

Recently another benefit has been added. If you end up saving too much, you can roll $35,000 of it over to your Roth IRA after all is said and done (provided the 529 is at least 15 years old)!

Alternatively, you could change the beneficiary to another kid (or grandkid) if the first one doesn’t end up using it all!

Coverdell Education Savings Account (ESA)

A Coverdell ESA can be used independently or along with a 529 plan as a savings account for college.

Similarly, this allows tax-free withdrawals so long as the money is used for school-related expenses. But the distributions for an ESA are more flexible than a 529 and can be used for a wider variety of costs.

A big positive for this type of account is that there is a much wider range of investment options than for a 529 plan. You have far more control over how you want the money to be invested.

A few rules to be aware of:

• The account must be established before the 18^th birthday of the beneficiary.
• The funds must be used before the beneficiary’s age of 30. If funds remain at the age of 30 (except in special needs cases), the remaining funds will be distributed and subject to income tax and a 10% penalty on the gains.
• Only families with an income below a certain threshold are allowed to contribute to an ESA. This threshold is $110,000 for single filers and $220,000 for joint filers (as of 2024). The max annual contribution phases out as the earner approaches this level.

It’s important to note that, for those below the high-income threshold, a maximum of only $2,000/year can be placed into an ESA.

But that means you could take that $2,000 child tax credit and simply dump it into an ESA, making the government pay for your kids’ college!

Uniform Gift to Minors Act (UGMA) / Uniform Transfers to Minors Act (UTMA)

If you’re not confident that your child will be attending college, but want to leave the door open for them to use your gift of funds for any purpose, you might consider an UGMA or UTMA.

Funding these accounts are essentially an irrevocable gift to the child, which they will immediately have access to once they turn 18.

An UGMA can hold only financial products.

An UTMA can hold financial products along with real assets such as real estate.

The downside is that these are taxable accounts, with a very small tax benefit on the dividends, interest and capital gains.

Also, if the annual contributions to such an account exceed the annual gift exclusion ($18,000 for individuals, $36,000 for joint filers), then this can trigger the gift tax and count against the donor’s lifetime gift and estate tax exclusion.

This is usually a good option to consider if it’s not specifically meant for college. Instead, it might be for a first-time house purchase, a wedding, a car, or simply an emergency fund for when they launch out on their own.

Conclusion

In summary, here is what you should keep in mind when saving for college:

• Assuming you qualify by income, saving $2,000/year into a Coverdell ESA is a way to put the child tax credit of $2,000 to good use. Make the government pay for college tax-free!
• A 529 plan can be used for contributions beyond $2,000/year (no annual maximum besides the total maximum). Like the ESA, these withdrawals come out tax-free when used for qualifying expenses.
• The UGMA/UTMA offers a way of giving the beneficiary a strong boost in early life, allowing access to the funds at age 18. This is a taxable account, so not ideal specifically for college savings relative to the other options. This is best used for things other than college, such as a house down payment, wedding, car or emergency fund for the young adult.
• And of course, the earlier you start saving, and the bigger the early contributions, the more time you have to put exponential growth to work for you!

College costs have been a mountain standing between young people and their early ability to build wealth rapidly in recent years. But with the right amount of planning, your kids or grandkids can have a massive head start in life.

A clean slate with no debt makes a world of difference in those first few years!